They raised the debt ceiling, so why the panic?

Aug. 18, 2011 12:00 AM

Question: I don't understand why stocks fell so much after the debt-ceiling agreement was passed. Why did this happen?

Answer: In recent weeks, just about everyone was watching and listening to what was going on in Washington and the debt ceiling debates. The prospect of a supposed U.S. government default had folks mesmerized.

As I've discussed in numerous recent articles, attention was being paid to the wrong issues because a default wasn't a possibility.

In a recent conversation with a nervous friend, I was asked if my friend should sell all of his stocks out of concern that the debt-ceiling legislation might not pass and that the U.S. would default. I pointed him to my recent articles on the topic and told him a default was virtually impossible. And then I warned him that what ends up moving the markets is something unexpected. Little did I know how true that would be so soon.

When it was clear Congress reached a debt-ceiling deal, initially the major market U.S. stock indexes moved more than 1 percent higher. That might have led some to believe that stocks had clear sailing ahead. Such thinking proved shortsighted and wrong.

Worse-than-expected manufacturing data and a downward revision in the first-half GDP numbers contributed to U.S. stocks actually falling rather than rising on the "good news" of a debt-ceiling deal. The reality was that those in the know in the stock market were sure a deal was going to happen - the only question really was how much longer it would take. So while it was good news that we wouldn't have to experience a multiweek government shutdown as we last did in 1995, the agreement was really nothing special.

Stocks got pounded the week that the debt deal was done. Stock prices fell especially sharply in Europe, where the sovereign debt crisis and anemic economic growth have investors rattled. Pundits are coming out of the woodwork in the U.S. proclaiming a double-dip recession or a dreaded depression.

As has happened multiple times in the U.S., central bankers in Europe are taking further action to bolster their economies and prevent deflation. In the meantime, remember that stocks have not only risen tremendously the past two years, but also rose sharply since the summer of 2010. The Dow Jones Industrial Average, for example, rose from less than 9,700 to more than 12,800 - that's an increase of more than 31 percent in less than a year.

Corrections like we are in now are inevitable and necessary for the market to eventually move higher. Now, of course, the question on many people's minds is whether this is just a correction or a new bear market, perhaps even another horrendous bear market like we had back in 2008.

While anything is possible, continued solid corporate profit reports suggest that stock prices are quite reasonably valued and that this is likely just a normal correction. With prices now down more than 15 percent, the worst is likely behind us rather than in front of us. But all of us remember what happened in 2008 when we had a once-in-a-lifetime bear market. Sure, it could happen again, but odds are against it.

The global economy is growing. Even though many U.S. corporations are doing little if any hiring domestically (witness the current 9.1 percent U.S. unemployment rate), they are hiring overseas due to growth in selected overseas countries.